Saturday, March 28, 2009

Back to The PPPIP

The new administration thinks that their plan will work as follows:

- Rip off the taxpayer to create a great deal for private bidders in acquiring junk assets from banks

- The banks, now that they have received a taxpayer supported, higher price for their junk assets, will lend again

- Economy will be saved

We all know that I hate this plan and that the only solution is bank nationalization. One of the big ones (Citigroup or Bank of America) will be reduced to a zero stock market value, but they probably all should be annihilated. I truly believe that the entire system is insolvent.

Anyway, you would think that as a result of this plan, the junk assets would improve in price. However, that is not the case.

The above graph tracks the price of credit default swaps on asset backed securities. The principal underlying loans for these securities are residential mortgages. The blue line shows the price range for each index and the red tick mark indicates Friday's closing price. For this index, the lower the price, the more expensive the credit protection. Notice that some indices hit new all time lows on Friday.

The above graph tracks the price of protection on securities backed by commercial mortgages. It works the opposite way: the higher the spread, the more expensive the protection. Once again, new highs for some indices.

So, either the market believes that the plan will not actually come to fruition or that the assets are so junky, that there is now way to save them. Either way, the rally in bank stocks is premature.

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